The housing market’s future seems unclear to some, but it all comes down to several key factors
By KRISTINE SMALE
As we begin another year, we tend to look back over the previous 12 months and assess our wins and losses. The US housing market also had wins and losses in 2018 and is ending on a note of doubt. Despite record low resale supply and strong demand in the spring, the fundamentals have shifted. In some markets, such as San Jose, this has happened very quickly. We rated the San Jose housing market as being “Very Strong” in July, but fundamentals have declined so significantly that it is now ranked “Very Slow.”
We at John Burns Real Estate Consulting recently revised our outlook for 2019 due to a significant pullback in demand, which has persisted over the past three months. Almost all national economic indicators remain strong; yet unsold new home inventory is above historical averages. This has occurred despite the 3.7 percent unemployment rate, the lowest in 50 years. Our new forecasts call for flat single-family permit levels, fewer resale home sales, minimal new home price appreciation, and small price gains on resale homes. However, this increasingly bearish outlook on residential for-sale housing causes a more bullish take on multifamily. We now forecast higher rent growth and an increase in multifamily permits, a much more positive outlook than our previous thesis when new-home demand was stronger.
We believe the pullback in housing demand has been caused by rising interest rates (faster than we projected), and a psychological shift caused in part by fluctuations in the stock market as well as negative media headlines about the housing market. We observe this slowdown in demand primarily in the move-up price points and in tertiary markets
“Affordability” has become the buzzword of the housing industry and, even if price increases start to moderate as we expect they will, more challenges to affordability loom. Rising interest rates pushed already unaffordable, hot housing markets (San Jose and Seattle for example) even further out of reach. The consensus is that mortgage rates will continue to rise through 2019, which will put increasing pressure on housing demand. Every 100-basis- point-increase prices an additional five million people out of the housing market.
As we look forward to 2019, we are watching several economic factors very closely.
- Mortgage rates: When the Fed hikes rates, mortgage rates follow suit. We are eagerly awaiting the announcement on December 19th at 2PM about the Fed’s decision on rates.
- Builder confidence: The most recent report from the National Association of Home Builders cited a 60-point drop in builder confidence, primarily due to affordability concerns. If builder confidence continues to weaken, we expect more price declines as builders rush to move through standing inventory.
- Builder costs: Continued cost increases combined with slowing price appreciation means smaller margins for builders.
- Consumer confidence: Sometimes consumers can enact a self-fulfilling prophecy. If general concerns about the economy increase, it could cause a pullback in consumer spending even sooner than anticipated, which would pump the brakes on the economy sooner than most economists expect (the majority are calling for a recession in 2020).
Yes, there is a great deal of uncertainty in the housing market today, and we are more bearish as we close out 2018. However, any future market downturns are expected to be moderate compared to the Great Recession. In the last boom, artificial demand fueled excess supply and higher prices. This time, legitimate demand overwhelmed supply. We at John Burns believe in the inevitability of market response. Prices will moderate. More people will enter the construction-labor force. Land sellers will lower their expectations. Incomes will rise. Housing starts will rebound. But in the short term, we can expect to see some of the same phenomena witnessed in the last downturn: increased incentives and potentially price depreciation in some markets, delayed home purchases and domestic migration to the more affordable markets.
As the housing market loses steam and economic activity eventually slows, builders and developers must reevaluate their strategies. First, they must measure their tolerance for risk – are they short-term, medium-term or long-term investors? We recently surveyed our Clients, and 55 percent told us they believe entitling land is the worst risk-adjusted return, but 12 percent are making the contrarian move and purchasing land, hiring the right entitlement teams and positioning themselves well for when the market inevitably turns again. A low-risk Client may have started refinancing debt and disposing of unwanted assets nearly 12 months ago when it was apparent the housing market was in its late growth stages. Most of our Clients tend to have medium-term risk, and we assist them with realigning their strategy, recapitalizing and staying well-informed about their local markets. Whatever your risk tolerance and long-term strategy is, the time to act is now.
Kristine Smale is the Vice President of John Burns Real Estate Consulting. She may be reached at firstname.lastname@example.org.